Jack Sirard: How to make money if housing market drops

By Jack Sirard -- Bee Staff Writer

Q: The real estate market has been on fire, and REITs have been a fairly good addition to anyone's portfolio. Yet there has been a lot of talk about a real estate bubble, similar to the tech bubble of the 1990s.

If there is a bubble and it's due to burst in the next year or so, is there a way to short real estate? - Hank D., Sacramento

A: You could sell some real-estate stocks short, meaning that you sell stock you have borrowed for a predetermined period. If the price of the stock falls, you purchase it and return the shares, pocketing the difference.

The danger, however, is that the stock will climb once you short it.

If you take the opposite -- and far more common -- approach and buy a stock, you know that your potential loss can only be what you invested.

If you want to short real estate, you have many different stocks in the field.

For instance, you could short one of the many real estate investment trusts that you note have done well this year.

Or you could short one of the nation's publicly traded home builders. You might want to look for one that markets to first-time home builders. Of course, many are private regional companies that would be off-limits.

In addition, you could go a bit further afield and short stocks that deal in real estate mortgages, such as Fannie Mae or companies that provide home-building materials and supplies.

While the real estate industry is red-hot in California, that's not necessarily the case in all other parts of the country.

Also, a home is a great tax advantage investment and, historically, real estate has kept up with inflation.

There's certainly been a lot of talk about the so-called housing bubble, but for the most part, even if a home declines in value for a while, the homeowner will not sell it.

Q: What is going on these day with United Airlines? Is it out of bankruptcy protection yet? What symbol does it trade under, and what exchange lists it?

- Lynn B., Sacramento

A: United Airlines stock trades now under the symbol UALAQ.QB on the over-the-counter bulletin board market. The share price closed Thursday at 60 cents.

Most of the experts on Wall Street expect the airline's shares to be worthless when the bankruptcy process wraps up.

Last week the company said it had not decided whether to try to exit Chapter 11 bankruptcy protection late this year or early next. Its overall plan is to fix its problems before exiting from court protection.

The company is reported to be in negotiations to get the necessary loans that would replace special bankruptcy loans that it has been using.

The airline filed its bankruptcy petition in December, the largest such case ever in aviation history. At that time, it said it expected it would take 18 to 24 months to emerge from bankruptcy protection.

Q: We have custody of our twin granddaughters. They turned 17 on July 2, 2003. Are we eligible for the advance (child tax credit) payment? And, will we get the tax credit next year since they were 16 half of the year?

- Bev G., Sacramento

A: Because the children turn 17 this year, you would be ineligible to receive the check, IRS spokesman Bill Steiner says.

He notes that the IRS double-checks with Social Security records to verify those eligible for a payment of $400 per child.

Starting today, the IRS will begin issuing advance payment checks to about 25 million taxpayers who claimed the child tax credit on their 2002 tax return. Those who did not claim a child tax credit on their return will not receive an advance payment.

The payment is an advance refund of the expanded child tax credit for the 2003 tax year. The child tax credit will increase to a maximum of $1,000 per child from $600.

Generally, taxpayers are eligible if you claimed the child tax credit on your 2002 tax return and the child was born after 1986. The IRS will send you a notice of your advance payment amount a few days before your check is mailed.

Q: I am thinking of investing in the Wilshire REIT Index Fund (ticker symbol RWR). Could you give me an opinion on this investment? I am somewhat conservative but would like to get a better return than what the money market fund is paying.

- Bill T., Fair Oaks

A: Actually called streetTRACKs Wilshire REIT Fund, it's an exchange traded fund run by State Street Global Advisors. The fund managers try to match the price and yield performance of the Wilshire REIT Index.

The fund has a lot going for it, including a very low expense ratio and decent returns.

It closed Thursday on the American Stock Exchange for about $131.58 a share, off its 52-week high of $132.94 and well above its low of $104.

Among its top holdings are Equity Office Properties Trust, Simon Property Group and Equity Residential Properties.

As a REIT, it falls on the value side of the equation, which cuts down your risk but won't net you large rewards either.

Morningstar reports that this fund, which was started in April 2001, has virtually been in the black since its inception. The fund gained 2.2 percent last year and is up 13.2 percent this year. In addition, it has a very comfortable yield of about 5.3 percent.

While the fund has not been around all that long, the index that it mirrors has and has performed quite well.

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About the Writer
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The Bee's Jack Sirard can be reached at (916) 321-1041 or jsirard@sacbee.com.

Be Realistic About Risks Of Real-Estate Investing

By Patrick Barta
Special to RealEstateJournal.com

Question: I have a $450,000 mutual fund portfolio, which is now down to $300,000 with the way the market has been going. I want to start investing in real estate. What do you recommend I do? Should I start off by buying a house, living in it for a year, and then renting it out? I am enrolling in a real-estate course, and I hope to make real-estate investing my career. I am 25 years old. What's the best way to get started?

-- Name withheld

Answer: So you're ready to dive into real estate. What's the first thing to do? Get a reality check.

Making a living by investing in real estate isn't as easy as it might seem, and if you're looking for something that's going to give the kinds of easy returns that stock-market investors rode in the late 1990s, think again. Establishing a career in real-estate investing requires a lot of work.

"You don't just say, 'Hey, I'd like to do accounting,' and go to a few seminars, and become an accountant," says Russ Whitney, author of "Millionaire Real Estate Mentor" (Dearborn Trade Publishing, 2003), a real-estate investing book. "Real-estate investing is the same."

That said, if you're willing to put in the time, owning real estate can be a good way to make a living. You should start by doing as much research as possible. Read as many books as you can get your hands on. Attend as many seminars as possible. And talk to as many real-estate investors as you can find. They're easy to locate: Most major cities have real-estate investing clubs that meet regularly. (To find contact information, try the website for the National Real Estate Investors Association: www.nationalreia.com. Another good website, www.mrlandlord.com, has chat rooms for investors and lots of other helpful links.)

You'll also want to contact at least one real-estate agent who specializes in investment properties. While most realtors focus on buyers who are buying properties to live in, some cater to buyers who plan to rent out the properties, and they can pass along lots of intelligence about the amount of rent owners are charging, and what investors are paying to buy rental units.

Often, however, the only way to learn is from experience, especially since many of the people you'll be contacting -- including even some realtors -- won't necessarily have your best interests at heart. Books will preach get-rich-quick strategies and seminars will promise huge returns, but there's nothing like putting your own hard-earned money on the line to learn the risks and rewards of owning a house or an apartment.

If you don't already own a home yourself, you'd be smart to buy one. You'll learn a lot about the mortgage process and the economics of owning real estate, and you can always rent it out later once you've learned more. Or, you could buy a duplex or triplex, and rent out the units you don't use. That way, you can keep an eye on the other properties while using the rental income to help offset your monthly housing costs.

Once you're ready to start buying more properties, you'll need to do some serious thinking about what kind of investor you want to be. If you're handy with a hammer, you might want to focus on properties that you can fix up, boosting their value in the process. But if you're not keen on getting your hands dirty, or running a contractor's crew, you might want to stick to apartments or houses that are ready to rent. Also, do you intend to hold on to the properties for the long term, or flip them for a quick profit? It's usually wiser -- and easier to make money -- if you hold the properties for a long time. But many real-estate investors have made good returns by buying properties that are undervalued for some reason -- perhaps the owners are divorcing and have to sell -- and then quickly reselling them to another buyer.

Whatever you do, though, don't do it lightly. Buying and selling real estate without doing a lot of homework is like going to Las Vegas without knowing how to play cards. The more work you do, the more you'll improve the odds you'll come out ahead.

-- Mr. Barta is a staff reporter for The Wall Street Journal. His "House Talk" column appears every Friday exclusively on RealEstateJournal.com.

Battling Segregation

L.A. opens debate on affordable housing

By Robert Greene

The new City Council finally showed up for work on Friday.

The five freshmen and 10 veterans had been meeting for two weeks, but it was getting hard to tell. For the most part, they looked like the old council — verbose, but in a quiet sort of way. Polite. Patient. Hardly the activists of the campaign season or the young first-termers who promised to lock horns with the establishment and pass sweeping progressive legislation.

They even seemed missing in action for a while during Friday’s presentation on child poverty in Los Angeles. Each member rose to offer stock words of alarm at hearing what they already knew — that thousands of L.A. children live in squalor and are at risk of emerging into adulthood without health care, housing, a meaningful education or jobs.

Then Ed Reyes erupted. The wonkish city planner and aide, who surprised even himself two years ago by being elected to the council, abruptly steered the exchange of platitudes into a confrontation over economic segregation. Lashing out at zoning protections that he said kept high-tone neighborhoods off-limits to working families as effectively as the long-banished racial covenants once did, Reyes challenged his colleagues to open up their wealthier districts to hearings — on where to put low-cost housing.

“What’s it going to take to bring this kind of decision making, where you are willing to challenge the homeowner associations, the preservation groups and the folks who are going to tell you why you should not have affordable housing in your district?” Reyes demanded.

The councilman from the densely packed, immigrant-populated 1st District was expecting to take the full weekend before revving up his campaign for an inclusive zoning ordinance — a law that would require developers of market-rate housing to reserve 10 percent to 20 percent of their units as “affordable” properties. But after a decade of studying the issue as a planner and half a term wrestling with it on the council, it was as if he just couldn’t hold it in any longer. His spirited outburst, and Tom LaBonge’s impassioned and somewhat alarmed defense of established neighborhoods like his 4th District’s Hancock Park, broke open a hole in the council’s self-imposed politic silence on re-allocating resources.

Through that hole gushed the full reservoir of challenges, confrontations and — maybe — solutions that the city will face over the next few years. Eric Garcetti, clearly pleased that the issue was finally getting some play, joined Reyes and members of the Association of Community Organizations for Reform Now at a Monday news conference on inclusionary zoning. So did Antonio Villaraigosa, who warned that a population the size of Chicago’s is expected to head toward Southern California in the next decade — and will need a place to live.

Later the three men, joined by Jan Perry, presided over a sometimes-raucous hearing at which union activists exchanged jeers with uniformed Wal-Mart workers over plans to severely restrict “big box” superstores. There was talk of beefing up living-wage laws. Utopian proposals to remake Los Angeles into a city of understanding and abundance suddenly seemed workable.

But then some of the union people at the big-box hearing chastised themselves for verbally attacking their unrepresented brother and sister workers, and in the process mirrored an uncertainty over tactics now faced by council members grappling with poverty and unequal distribution of resources.

For example, should an inclusionary zoning ordinance permit builders to keep affordable units out of their big apartment complexes and housing developments if they pay a hefty fee or promise to build the affordable units elsewhere? Yes, say some advocates quietly, because that compromise will bring crucial support from council members who are otherwise skeptical of new mandates on builders — and new neighbors in their districts. No, say more aggressive reformers, who insist that the whole point of the ordinance is to ensure that teachers drive the same streets as bank executives, that housekeepers attend the same PTA meetings as film producers, and that police officers do their grocery shopping in the same stores as cosmetic surgeons.

“We want the children of janitors to grow up right next to the children of lawyers,” Garcetti said. “We want doctors and working people to have their families together, because that’s what this city is about.”

Even the closest of allies on the housing issue have yet to show they are completely on the same page. Garcetti, for example, must send chills up the spines of wealthy homeowners and business interests when he calls for “affordable housing in every neighborhood in the city.” Reyes insists instead on carefully targeting affordable housing to “the most appropriate areas.” They might mean the same thing, but they are still working the bugs out of their collective pitch and may come to rely on Villaraigosa’s skill at articulating a collective vision and crafting workable legislation.

A quick head count still leaves the trio short of a majority on affordable housing and other progressive lawmaking. Their homework will include lobbying not just their colleagues from the liberal but insular Westside and the more conservative Valley districts, but also the representatives of South L.A.

Bernard Parks doesn’t quite say he supports gentrification, but has called for more market-rate building in the 8th District to pick up the standard of living there. The practical Jan Perry must balance the needs of her poor 9th District constituents south of the Santa Monica Freeway with the downtown business interests who pay the tax bills. Neither is shy about defending their district. But Parks and Perry could be won over — they have hired Reyes’ old boss, ex-Councilman Mike Hernandez, who began pressing his colleagues for housing equity a decade ago.

Reyes, meanwhile, is suddenly in a hurry. He has been working on the issue for about a third of his life, but the exit last month of five of his colleagues and the arrival of five new members jolted him into noticing that the first two years of his term were history.

“We have to talk about where we can build new housing,” Reyes insisted on the council floor Friday. “In the age of term limits, we are running out of time.”

The latest wrinkle in refis

Some banks are offering a new way to refinance: a home-equity line of credit. Should you try it?
By Jean Sherman Chatzky, Money Magazine

NEW YORK (Money Magazine) - When customers approach a lending officer at Pittsburgh-based PNC Bank to refinance their mortgage, they're offered a menu of choices. One of them is not a refi at all.

At PNC -- and, we hear, at many other banks all across the country -- homeowners are being encouraged to take out a home-equity line of credit (HELOC) and use that stream of cash to pay off their first loan. That's one reason that outstanding HELOC debt has climbed from $163 billion in 1999 to $359 billion in 2002.

It sounds like a tempting offer.

According to HSH.com, which publishes mortgage-rate information, 15-year fixed-rate loans are now going for 5 percent. You can get a HELOC at prime, currently 4.25 percent, in just about any market in the United States.

Moreover, on a refi you'd pay an average of half a point -- or 0.5 percent of the amount of the loan -- in closing costs and another half a point in legal fees and appraisals. Closing a HELOC at PNC runs just $21.

"It makes sense," says Mike Moll, director of marketing at PNC. He not only swapped his own 6.875 percent, 30-year fixed-rate mortgage for a HELOC at 4.25 percent but also sold his brother and brother-in-law the same deal.

Pros & Cons of HELOCS Taking out a home equity line of credit might be better than a refi. Pro/Con Topic Justification Pro Closing Costs The average fixed-rate refi adds a closing fee of 0.5 percent to the cost of the mortgage. A HELOC costs as little as $20. Pro Interest Rates Mortgages now hover in the mid-5-percent range. A HELOC is typically written at the prime rate, 4.25 percent lately. Con Interest Rates If interest rates rise quickly, your prime rate HELOC will jump. A fixed-rate mortgage is better insulated against this shock. Con Ease HELOCs require active maintenance -- watching interest rates like a hawk. A good refi is "set it and forget it." Source:

Is Moll right? He's definitely onto something, says George Yacik of SMR Research, which maintains data on the HELOC market.

"For people who have $90,000 in mortgage debt and a $1,000,000 credit line," Yacik notes, "writing themselves a check is equivalent to a quick refi -- a free refi."

But even if it's fast and cheap, it may not be smart. The reason: A HELOC is an adjustable-rate loan.

"The question you need to ask yourself is, why would a bank be pitching you this product at this time?" says HSH's Keith Gumbinger. "The obvious answer is that bankers believe rates will rise in the future. Getting you out of a fixed loan and into a variable one helps ensure profitability on your account."

Moreover, he notes, when rates rise, they can do so very quickly. The period of interest-rate hikes we experienced beginning in 1998 saw rates rise two points over a year and a half. A jump like that would make today's 5 percent fixed-rate mortgage look downright cheap.

Different scenarios

So what sort of customers does a home-equity arbitrage like this make sense for? Gumbinger ran some scenarios to see. Here's one.

Let's assume you bought a home 10 years ago, taking out a $300,000, 15-year fixed-rate loan at 7 percent, and you've never refinanced. Your monthly payment on that loan is $2,696. Today you have an outstanding balance of $136,200, of which $26,000 is interest.

Refinance the balance into a new 15-year mortgage at 4.98 percent, and your monthly payment slides precipitously to $1,075. But if you take the full 15-year period to repay the loan, you end up more than doubling the total interest you pay, to $56,000.

What if you instead take the HELOC with a 20-year term at 4.25 percent? If rates stay low, you're golden. But if they rise 1 percent a year until they hit 7.5 percent -- the average prime rate over the past decade -- your monthly payment climbs from $843 in the first year to $1,073 in years five through 20. Over the 20 years, the interest will total $114,000.

There is a way to save real money in this situation: prepay like crazy.

If you continue to pay at your old rate on the new 15-year mortgage, you get out in 56 months and save roughly $6,500, after $2,600 in closing costs. If you opt for a HELOC instead -- assuming you get one with no prepayment penalties -- the absence of closing costs and the lower starting rate would about double your savings, even if rates go up 1 percent each year.

Is it worth it? It may well be -- but only if you have the stick-to-itiveness to watch rates like a hawk and quickly lock in a new fixed-rate loan if they start to rise. PNC's Moll thinks he can do that. Then again, he works in a bank.

Mortgages come in new flavors

By Thomas A. Fogarty, USA TODAY

Good times continue to roll in the mortgage business. With interest rates clinging to 1950s levels, the industry is on track to originate more than $3.3 trillion in new loans this year, shattering the record set in 2002.

Frantic competition is helping to foster a wider variety of mortgage offerings and some new-style lenders.

The garden variety 30-year fixed-rate mortgage with up-front costs continues to be the favorite of most lenders and borrowers. But the hot mortgage market has created niches where borrowers can look for a different kind of deal. Here's a look at portable mortgages, no-cost mortgages and some new style ARMs-only lenders.

The portable mortgage

Internet lender E-Trade Mortgage last month introduced what it calls "Mortgage on the Move," a deal that allows borrowers the one-time option of carrying over the terms of their home loan to a new residence.

The portable mortgage gives the borrower a way to hedge against interest rate increases. The option comes with a higher interest rate. Thursday, a creditworthy borrower could get the portable mortgage at about 0.4 of a percentage point above the lender's rate for a normal 30-year mortgage.

The portable mortgage, so far unique to E-Trade, makes sense only in the current prolonged trough in mortgage rates, which are as low as they've been in about 45 years. Once rates begin to rise substantially, customers aren't going to be inclined to pay the premium to lock in terms through their next move.

Robert Bernabe, head of retail lending at E-Trade, says the mortgage will be available as long as it continues to make sense for customers seeking protection from an upswing in interest rates.

At origination, the portable mortgage looks like a regular 30-year fixed rate loan. But here's what happens when a borrower moves:

• If the borrower downsizes, the monthly payment is recalculated to amortize the new balance over the remainder of the 30-year term of the loan. That ensures the monthly payment won't increase.

• If the borrower upgrades, and more money is needed, E-Trade is committed to issuing a second mortgage on the new house. The deal calls for the second mortgage to be issued at prevailing rates for a first mortgage at the time the new home is purchased.

First mortgages typically carry interest rates two percentage points or more below second mortgages.

The portable mortgage is available only for purchases, not refinances. They're limited to 80% of the appraised value of the home.

Who could benefit: Borrowers who expect interest rates to rise and who are fairly certain they'll be moving in the next several years.

What to watch out for: The protection afforded by the portable mortgage comes at a price. Even if you know you'll be buying another house, the extra cost could be wasted money if interest rates are reasonably low when you make your next purchase.

The no-cost mortgage

All mortgages have closing costs. But lenders and borrowers have options in deciding how they'll be handled — by a customer's cash at settlement, by adding to the loan balance or by a higher interest rate charged to the borrower.

One hot option these days is the so-called no-cost mortgage. It simply means that the lender covers closing costs in return for the borrower paying a premium interest rate.

Skip Dyer, manager at DNJ Mortgage in Cary, N.C., explains the economics of the deal this way:

A borrower who would normally qualify for a 5.5% interest rate agrees to pay 5.75% to avoid payment of closing costs. The higher interest rate allows the lender to sell the mortgage to investors in the secondary market at a premium. A $300,000 mortgage at the elevated interest rate might bring the lender a premium equal to 1% of the loan, or $3,000.

It is the lender's so-called "yield spread premium" from the secondary mortgage market that allows a lender to cover closing costs in a no-cost mortgage deal.

Bob Walters, vice president at Quicken Loans, says no-cost deals generally work for lenders on loans of $110,000 or more.

If you go that route, your higher interest rate should eliminate charges for administrative fees, credit reports, appraisals, title insurance, settlement services and the like. It probably won't eliminate payments to the lender for daily interest charges, or for advance payments for property taxes and homeowners insurance.

Who could benefit: Refinancers who can improve on their current interest rate or home buyers short on cash.

What to watch for: Lenders' marketing claims are confusing. When a lender promises, for example, "no out of pocket costs," it doesn't mean you're getting a no-cost mortgage. It just means closing costs are being rolled into your loan balance. Keep in mind that you're paying a premium interest rate for sidestepping normal closing costs. If you plan to have the mortgage for a long time — say, eight years or more — you're likely to be money ahead by paying the closing costs up-front.

ARMs only

At least two big lenders have given up entirely on the notion of fixed-rate mortgages. Dutch-owned ING Direct and New Mexico-based Thornburg Mortgage make only adjustable-rate loans. ING Direct offers initial fixed-rate periods of up to seven years; Thornburg, up to 10.

From a borrower's point of view, their logic is hard to fault. Thirty-year and 15-year fixed rate mortgages give the borrower certainty about future house payments, but the certainty comes at a price. Their interest rates are higher than mortgages that adjust periodically to reflect market conditions.

Most estimates peg the average tenure in a home at about six years. The result: Most fixed-rate borrowers are paying a premium price for long-term financial security they're not around to enjoy.

"Our consistent message is that if six years is the average, don't get a 30-year fixed rate mortgage," says Thornburg President Ron Chicaferro.

ING Direct Vice President David Lewis says customers are almost always financially ahead by accepting some risk for future interest rate increases.

A company review of data back to 1979 suggests interest rates "just haven't been volatile enough" to justify the cost of locking in an interest rate for the long term.

Another company study showed that borrowers who in 2002 paid off 30-year, fixed rate mortgages that were five years old paid $7.5 billion more than they would have had they taken out a mortgage that allowed rate adjustments after five years.

Who could benefit: Anyone who is fairly certain to move in the next 10 years. For those who don't want to gamble entirely on short-term movements of interest rates, experts recommend balancing expected tenure in the house with a mortgage carrying an initial fixed period to match. Example: Someone expecting to be in a house seven years should look for an ARM with a fixed rate for the first seven years.

What to watch out for: Averages aside, many homeowners will be around long enough to reap the rewards of a long-term fixed rate. And even if your future in the house is uncertain, the predictability and peace of mind of a fixed rate is worth something.

Is a Portable Mortgage. Something to Consider?

By Queena Sook Kim
From The Wall Street Journal Online

July 9, 2003 -- Mortgage rates haven't been this low in roughly 40 years. So wouldn't it be nice for home buyers to lock in today's rate for all home purchases in the future?

So-called "portable" mortgages let borrowers do just that. This new product, offered by E*Trade Mortgage, allows soon-to-be homeowners to transfer the loan -- while hanging on to the earlier rate -- from one home to the next.

One catch: Your rate will be slightly higher than the going rate. The lender says the higher rate reflects the longer life of the loan. Regular 30-year fixed loans are typically paid off in five to seven years when homeowners move or refinance their loans, at which time banks can profit by lending out the money again. E*Trade assumes that home buyers will keep the mortgage for a full 30 years. Such loans aren't available to homeowners looking to refinance.

The online lender began offering portable loans earlier this month in a bid to expand its mortgage business. E*Trade Mortgage originated $6.2 billion in mortgages in 2002, or far less than 1% of the overall $2.5 trillion in U.S. home mortgages taken out last year.

The approval process for a portable loan would be the same as for a typical 30-year fixed, and a traditional 20% down payment is usually required. E*Trade lends mainly to borrowers with high credit ratings.

How does a "portable" loan actually work? Consider Gregory and Gwen Jones. After hearing about E*Trade's "Mortgage on the Move" offer, the Phoenix couple locked in a rate three-eighths of a point more than a regular 30-year fixed loan that day. At first, they weren't sure the higher rate would pay off.

The newlyweds are buying their first house and plan to move back to their native Northwest in three years. Mr. Jones liked the fact that E*Trade doesn't charge fees for the straight transfer of a loan to another property of the same or lesser value. But there are fees if the second property is of greater value, requiring a second mortgage.

If the Joneses move to a costlier home, E*Trade will transfer the remainder of the mortgage to the new house at the same rate. Then the lender will offer the family a second mortgage at the same interest rate as a first mortgage. Fees will be charged for the second mortgage, and homeowners are required to get the loan from E*Trade. That allows the lender to maintain a lien on the house.

E*Trade charges borrowers a set fee of $995, but after including third-party costs like title insurance and tax, the total cost is about $2,190. The estimate doesn't include points paid by borrowers for a lower interest rate.

Mr. Jones said he was comfortable with the arrangement because E*Trade's loan rates are competitive with those at other lenders. On the flip side, if the Joneses were to move to a cheaper house, they could reduce their mortgage without a penalty, while keeping the earlier rate.

Currently, E*Trade is the only lender offering such loans. And others aren't rushing to follow.

Market conditions will dictate how long these portable loans are available, says Robert Bernabe, head of retail-mortgage lending at E*Trade. "We'll stop when rates rise to a certain point and the product isn't attractive to customers."

When Is Refinancing. In Your Best Interest?

By Patrick Barta
Special to RealEstateJournal.com

Question: My husband and I are currently in the eighth year of a 15-year mortgage. Our monthly payments are approximately $1,700 and we have $131,000 left on our loan. Does it make sense to refinance for another 15 years at 5.375%? It would reduce our payments to $1,100 a month but since we currently pay more principal than interest, we're uncertain which direction to go. We are in our early 50s and our children are both graduating from college this year. Your thoughts, please.

-- Pat, Chicago

Pat: Don't worry about the fact that you're already halfway through the term of your mortgage. There's an easy way to make your refinance make sense: Pay down your loan early.

To illustrate this, consider a hypothetical scenario based loosely on your experience, provided by Bankrate.com, the consumer-finance web site. This scenario assumes that you took out a 15-year, $200,000 mortgage at 6.5% interest seven years ago, with a monthly payment of $1,740. The balance on this loan would now be about $130,000 and you would have paid a total of $76,500 in interest. If you keep the loan, you'd wind up paying another $37,100 in interest over the next eight years.

Now, let's say you decide to refinance. Doing so will likely cost you about $3,000 in fees. So whatever you do, you'll want to make sure you save more than $3,000 in interest over the life of your new loan, meaning that you'd want to pay no more than $34,100.

Simply refinancing into another 15-year loan (at today's rates of around 5% or less) and paying it down over the full 15 years probably isn't the best move, though it certainly would give you some more pocket change in the short run. Your monthly payments would drop to $1,028, saving you more than $700 a month. But you'd pay $55,045 in interest over the next 15 years, far more than you'd have to pay if you simply kept your old loan.

If you refinance into a 10-year loan, the math looks a bit better, but you still don't come out ahead on interest. Total interest over the 10-year span would be $35,500. With your closing costs added in, it's not a good deal.

Paying down your loan early, however, can dramatically change the numbers. Say you refinance into a 15-year loan at 5% interest and continue to make your old monthly payments of $1,740 a month until the loan is finished off. Under this scenario, you'd be done with your loan in seven and a half years, with a total interest bill of $26,000. Even after paying closing costs, you'd save several thousand dollars on interest and be free of debt before you would have been had you kept the old loan. The numbers are more or less the same if you refinance into a 10-year loan and continue to pay $1,740 a month.

Of course, there are other ways to configure the payment schedule; for example, you could choose to pocket a little bit of the monthly savings if you want some more spending money and still finish ahead. For example, you could pay $100 less each month than with your old loan and wind up paying just $28,000 in interest over the life of the new one -- still a healthy savings; plus, you'll be free of debt in about eight years, the same as before. The critical point is to avoid extending the term of your mortgage. For example, if you only have eight years left on your home loan, you don't want to make payments for more than eight years on your new loan. And you most certainly wouldn't want to refinance from a 15-year mortgage into a 30-year loan. Pay as much as you can each month -- it only saves you interest in the long run.

Is Buying a Larger Home. A Wise Financial Move?

By Patrick Barta
Special to RealEstateJournal.com

Question: Our current house, which is almost 30 years old, has about 1,600 square feet of space, and is good enough for our family of three. However, we would like a newer and bigger home, and we're tempted to move up now, mainly because interest rates are so low, and we think a bigger house would be a good investment. Our current home is worth $160,000, and we have $48,000 left in our mortgage, so with the equity that we have, we think we can afford a $250,000 house. But is buying a bigger home a smart financial move? We'd have a bigger mortgage payment, moving costs, higher homeowner-insurance bills, and higher property-tax and utility payments. Should we stay put or move on?

-- Julie, Grand Rapids, Mich.

Julie: Most financial planners agree that if you can afford it, and if you don't mind carrying some extra debt, owning a bigger house is a good financial move. But those are big ifs, and it's important to put a lot of thought into your decision before moving forward.

For starters, it's dangerous to load up on unnecessary debt, a fact that's more evident than usual these days. Mortgage foreclosures are running at record levels, in part because too many families have been lured into buying bigger homes than they can afford in a distressed economy. If you're worried about taking on too much debt, a helpful rule of thumb is that you should avoid entering a mortgage whose monthly payment -- including taxes and insurance -- totals more than one-third of your gross pre-tax monthly income. (Don't expect lenders to tell you this: Many lenders will encourage home buyers to take on far more debt, in some cases twice as much.)

Even if you can afford more debt, there's also a question of whether you really want it. With just $48,000 left on your old mortgage, you could be free and clear of housing payments in only a few years. That would allow you to shift hundreds of dollars each month to other spending, or better yet, to investments for your retirement. Indeed, if your top goal is to build a nest egg, there are probably better ways to go about it than socking your money away in real estate. Even the stock market -- despite the dismal results of recent years -- pays a higher return over the long haul.

That said, if you still feel like you're ready to move up, there are lots of upsides to buying a larger, more expensive home. The most obvious is the intangible, emotional upside that comes with owning a nicer home: It can greatly improve your quality of life.

More important from a financial point of view is that if home prices continue to appreciate, you'll get a bigger bang for your borrowed dollar from a larger, more expensive home. For example, say home prices grow 5% over the next year. If you hold on to your $160,000 home, you'd wind up with $8,000 more in equity. But if you owned a $250,000 home, that same rate of appreciation would give you $12,500 in new equity.

Today's low interest rates -- and the fact that you already have lots of equity built up -- should help improve the odds you'll do well. If you sell your $160,000 home, you'll wind up with about $100,000 in equity once you pay off your old loan and pay a realtor's commission. If you apply all that money to a new $250,000 house, you'll wind up with a mortgage that only totals $150,000, which will likely cost you a little more than $800 a month at today's interest rates That's probably close to or even less than what you're paying now!

Linda Lubitz, a certified financial planner at The Lubitz Financial Group in Miami, recommends that families who are moving up take out mortgages whose monthly payments are equal to -- but not greater than -- the old home loans they're replacing. Her reasoning: Borrowers should aim for the highest amount of leverage they can afford, in order to get the best return on their borrowed capital, so there's little sense in paying less each month than you pay now (unless you just want more cash in your pocket). Paying more, of course, is always possible, but it also means you might have to trim back spending in other areas.

Ms. Lubitz offers another tip: With interest rates so low, it's possible you can get the same monthly payment you had before without using up all your equity for the down-payment on your new home. If that's the case, you could use some of that money to invest elsewhere, making the move-up even more attractive.

All of this, of course, assumes that the house you buy will continue to appreciate in value -- an outcome that is never 100% certain. And to increase the likelihood your home will appreciate, you might want to consider some compromises on the kind of home you choose.

For example, Lou Barnes, a mortgage banker in Boulder, Colo., argues that borrowers are better off avoiding the big, new houses that are sprouting up all over the country's suburbs; such houses, while possibly more attractive than what you own now, could appreciate less over time as builders add more, similar homes. A smarter move, he says, would be to "move up" to an older and possibly smaller home in a highly desirable neighborhood that's close to large employment centers and respected schools. Even though these homes may not have all the bells and whistles you're looking for in your move-up, they're more likely to gain value over the long haul.

Are Homebuilders on Shaky Ground?

STREET WISE
By Amy Tsao
The boom can't last forever, skeptics say, even as home prices keep climbing. Should it end, though, some outfits will feel less pain
Betting on a decline in the homebuilding sector's red-hot stocks has become a popular investing strategy of late. Too bad for the short-sellers, though, because they haven't had much to crow about. Thanks to record low interest rates, the homebuilding boom has continued -- and housing stocks continue to shoot through the rafters, despite the lackluster economy. The Standard & Poor's homebuilding index is at an all-time high, up about 45% since January, while the broad S&P 500-stock index is up 10% over the same period.
Can this go on? Yes and no. Homebuilding stocks were a clear buy after being beaten down during the uncertain months prior to the Iraq war (see BW Online, 3/03/03, "Homebuilder Stocks: Nice Fixer-Uppers?"). But given the year-long runup, the high percentage of short-sellers, and nagging concerns that the boom can't last, investors will need to be more selective. Still, those with a high tolerance for risk can find some good buys.

One way to play the sector is through companies whose geographic presence and pricing gives them above-average growth prospects. James Wilson, an analyst at San Francisco-based JMP Securities, figures homebuilders that focus on the midprice market and growing regions like the Southwest and Florida are best-positioned for the long-term. Companies he rates as strong buys are D.R. Horton (DHI ), an Arlington (Tex.) builder that was trading around $30 as of June 20, and Miami-based Lennar (LEN ), now about $74. (Wilson personally owns shares in D.R. Horton.)

BIG GAINERS? Wilson figures D.R. Horton's shares could climb to around $36 in the near term, a 20% increase. In its most recent quarter ended Mar. 31, Horton reported a 44% jump in net income and a 19% increase in revenues. He expects earnings per share for the fiscal year, which ends in September, to rise to $3.60, up 25% from a year ago. Over the longer term, the outfit's strong position in the Southwest's fast-growing markets will give it an edge, he figures.

Lennar may have the added attraction of being a consolidation play. It has been on an acquisition binge, with 11 buyouts in the last year-and-a-half. After it reported strong results for the quarter ended May 31, Wilson increased his 52-week target price on Lennar to $93, from $85.

Cary Nordan, an analyst at BB&T Asset Management, owns NVR (NVRBZH ), which caters to the entry-level homebuyers, and Hovnanian Enterprises ( ), a builder in McLean, Va., that operates primarily in the mid-Atlantic. She also owns Atlanta-based Beazer Homes (HOV) in Red Bank, NJ. "These companies won't have problems meeting next year's numbers," Nordan predicts. Though he expects some volatility over the next 12 months, he sees gains of as much as 20% to 25% in that time.

Beazer, which trades at around $90, might have the most short-term upside, Nordan believes. He views it as an attractive acquisition target that could command a premium if it's taken over.

"CRESTING." Hovnanian, whose stock was trading around $63 as of June 20, also could see strong gains, Nordan thinks. His reasoning: In late May, it said it would beat previous EPS guidance by at least 23% in fiscal 2003. Fiscal 2004 will likely be another stellar year, with expectations of an EPS rise of as much as 15%, to $7.50, thanks to low interest rates on mortgages, acquisitions of rivals, and rising home prices.

Then there's NVR, whose stock was trading near a hefty $413 as of June 20. But it has good prospects because its Northern Virginia base is benefiting from increased government spending in the capital region.

Of course, none of these stocks is a sure thing. Some analysts believe the nearly ideal conditions driving the housing market -- a combination of low interest rates, strong demand, and a comparatively weak stock market -- will start to fade if a recovery gains steam. The housing boom overall "is cresting," says Sherry Cooper, chief economist at Montreal-based bank BMO Nesbitt Burns.

FREDDIE FALLOUT. Most important, interest rates probably can't go much lower. The typical rate on a 30-year-fixed mortgage is now just 5.21%, the lowest since 1971, when such data began to be tracked. Many analysts worry that rates may start ticking up as early as 2004, when the Bush Administration's $350 billion stimulus package finally starts to revive the economy. "It's hard to imagine that a year from now rates won't be higher," Cooper says.

Then there's the waning demand for new homes in some areas. Home-ownership levels are already at record highs, and many believe the 2-to-1 ratio of owners to renters can't get much higher. Meanwhile, with the unemployment rate still rising, the pool of qualified new buyers is likely diminishing. Says Cooper: "It's hard to imagine there's a lot of pent-up demand left."

Finally, there's the potential fallout from accounting concerns at mortgage megafinancier Freddie Mac (FRE). So far, the reasons for the management shakeup that included the firing of Freddie's president and the resignations of its CEO and CFO aren't clear, but "as one of the major financers in the country, anything that would put that at risk would be a very strong negative," Cooper says. A disruption at the country's No. 2 mortgage company could have a chilling effect on mortgage lenders generally.

The bottom line: If the housing market cools and the equity rebound can keep its footing, investors will probably start looking around for new growth sectors. But even if homebuilders lose their luster, some could still outperform -- at least for awhile. "A premium is warranted on top of [homebuilders'] forward-looking prospects," argues Chris Jarvis, associate director of research at financial-advisory company Advest in Hartford, Conn. In select cases, what has gone up could keep rising -- even if the housing boom can't go on indefinitely.


Tsao covers the markets for BusinessWeek Online in New York
Edited by Thane Peterson

Getting more for your mortgage

Rates are lowest in over 50 years: Tips to help you get the most for your money

Rates for a 30-year mortgage are now below five percent — the lowest in over 50 years. Whether you’re shopping for a new mortgage or refinancing, you have many products to choose from. “Today” financial editor Jean Chatzky offers some advice to help you get the most for your money.

Think back to 1999. Every time you went to a cocktail party or out with friends for dinner, the topic would turn to stocks, as the participants tried to out-do each other with their soaring shares of Amazon or Ebay. Today, the parties are the same but the conversation’s different. Now you can’t escape the mortgage rate competition. You may have gotten a killer deal at 5 1/2 percent for 30-years, but your next door neighbor’s got you beat at five.

The mortgage market is this year’s little engine that could. Last week, the Mortgage Bankers Association reported — for the first time in more than 50 years — that rates on a 30-year fixed rate loan had fallen, on average, below five percent. Those low rates will drive, the MBA predicts, a record 3.3 trillion in mortgage originations in 2003; 68 percent of that activity, the MBA says, will come in the form of refinancing.

There’s one big difference between the mortgage activity we’ve seen over the past few years (which, themselves, have been far from sluggish) and this year’s: Last year was all about cash-out refinancing, consumers were pulling equity out of their homes (many of which had run up in value) to pay down their credit card debt, pay for college, home improvements or cars.

This year the trend is more conservative. Borrowers are swapping into shorter term mortgages. Instead of taking out 30 year mortgages, with interest rates so low, they’re looking at fixed-rate mortgages with 10, 15 or 20 year terms. Some people are looking at hybrid mortgages, that are fixed for the first five or seven years and then begin adjusting. And some are even getting rid of their conventional mortgages altogether in favor of home equity lines of credit that are a point to a point-and-a-half cheaper in rate with negligible closing costs.

WHY ARE THEY DOING THIS?

Two reasons: One is that rates have fallen so far that if you haven’t refinanced in a while, it may be possible to swap into a much shorter term without impacting your cash flow. But second, despite the fact that we’ve had a nice little run in the market, investors are still opting for safety. A recent Roper survey says that more today than at any time during the previous 26 years, Americans considering the best place to put their money want the safest place, not the place that will provide the most income or the most growth.

HOW DO YOU KNOW WHICH OF THESE SOLUTIONS — IF ANY — IS RIGHT FOR YOU?

To answer that question you need to come back to mortgage square one: How long are you going to be in that house? Are you planning on trading up in a few years when you have kids and earn more money? Are you planning on trading down in a few years when your grown kids flee the coop? Does your company move you every few years? Or is this your home for the foreseeable future?

THE RIGHT LOAN FOR YOU?

Less than three years: Home Equity Line of Credit

If you plan to be in your house for less than three years, you may want to consider refinancing into a home equity line of credit (HELOC). Now, not everyone can do this. In general, to get a competitive rate on a HELOC you can only borrow about 90 percent of the equity in your home — with a first mortgage you can borrow nearly 100. But rates are lower. In just about every market in the country, it’s possible to find a HELOC at 4.25 percent (the current prime rate). Even if rates go up a full point each year you’ll still be around 5-6 percent by the time you get out of this loan. The bigger benefit is the absence of closing costs which can run in the thousands of dollars. Because you’re not in the home for long, you may not have enough time to recoup them.

Three to seven years: Adjustable Rate Mortgage

If you plan to be in your house for three to seven years, look at a hybrid ARM that’s fixed for, say, the first five years then begins adjusting. On a $200,000 loan, your monthly payment on a 5-1 (4.2 percent) would be $979. That’s $140 less than it would be on a 30-year fixed rate loan (five percent) at current rates where the monthly payment is $1,119. Your savings over the first five years of that loan: $11,500. That’s some pretty serious money.

More than seven years: Fixed Rate Mortgage:

If you plan to be in your house for more than seven years, a fixed-rate mortgage is the way to go. Although activity in shorter term loans is creeping up, the 30-year fixed rate mortgage is still, far and away, the most popular product. If you like the idea of a 15, but don’t want to lock yourself into the higher payments, try making one extra mortgage payment a year. It can knock the term of a 30-year loan down to 23 years.

WHAT’S THE BEST WAY TO SHOP FOR ANY OF THESE PRODUCTS?

Personally, I got my most recent deal from a mortgage broker (and it was better than the ones I was offered by banks). But I’ve heard other people tell the opposite tale — and that’s just the way this market works. Sometimes you’ll get the best deal from brokers, other times from bankers, other times online. One thing you should always do is to go back to your old lender and ask about a streamlined refi, which is basically an abbreviated refinance with less paperwork and lower closing costs. But if they won’t give it to you (and we’re seeing lenders tighten up a bit here) you can always go somewhere else.

WILL THESE LOW RATES LAST?

As you know, I think trying to forecast interest rates is similarly tricky to trying to forecast the market. However, the economists I’ve polled at both HSH.com and the MBA believe that rates will hold through the summer, perhaps ratcheting up a quarter of a point but not much more than that. In all though, I think if you run the numbers to refinance and see that you can save enough money to make the hassle of the transaction palatable, you should do it. If rates drop further, you can always refinance again.

When Does a Home Sale. Trigger a Big Tax Bill?

By Patrick Barta
Special to RealEstateJournal.com

Question: We're living in a house that we're renting, but the owner plans to put it on the market. Although we ultimately plan to move, we're not ready to move just yet. So we're considering trying to buy the house -- it would be our first home -- and then either sell it or rent it out when we're ready to leave. My concern is this: Will we have to pay a big capital-gains tax if we buy and then sell the house?

-- Suzy, Seattle

Suzy: Don't worry. There's a good chance you won't have to pay capital-gains tax at all, and even if you do, it's still likely that you'll walk out a winner.

Here's why. Thanks to a 1997 tax law, married couples who live in a house for two out of the prior five years are excluded from capital-gains taxes for the first $500,000 of profit. For single persons, the limit is $250,000. Say the house is worth $250,000 the day you buy it. If you're married, the home's value would have to increase by 200% over the next two years before you pay capital gains. For the record, Seattle home prices rose 10.4% in the last two years, and the rate of appreciation has actually slowed over the last four quarters.

Even if you don't stay in the house the full two years, you might still be able to avoid paying capital gains. For example, if you have to leave because of a job, health problems or other unforeseen circumstances, there's a good chance you could qualify for a partial exemption from the capital-gains tax.

Of course, if you rent the house, that adds a new variable to the mix. If you live in the house a full two years before renting it out, it won't matter: You'll still get the maximum exemption. If you don't, you could wind up paying some capital gains when you leave. Even so, under the latest tax-cut plan approved by Congress, the capital-gains-taxation rate drops to no more than 15% from the previous 20%. And that's only 15% of your profit, meaning you get to keep the rest. "That, to me, is not getting hurt," says Gerald Marsden, a partner at Eisner & Lubin, a tax-consulting firm in New York.

The primary way you could lose is if you sell the home very quickly after buying it, though in that scenario the capital-gains tax is the least of your worries. You'll also be deep in the hole because of the numerous transaction costs that are involved in buying and selling a home, including a realtor's fee and the origination fee you pay to the lender for your mortgage. Short-term ownership of real estate is rarely a good idea, regardless of the potential capital-gains hit.

Impact of fiscal shakeup at mortgage-finance firm

Removal of officials at Freddie Mac unnerves financial markets, homeowners.

By Ron Scherer | Staff writer of The Christian Science Monitor

NEW YORK – When Congress sought to end accounting irregularities, few thought that the spotlight might fall on a company that was chartered by Congress itself and provides a service that touches millions of Americans.

But, now the klieg lights are on Freddie Mac, which purchases mortgages from home lenders so they can make new loans. On Monday, the company released its top three officials after questions arose over its earnings statements for the past two years. Congressmen are calling for hearings. And the financial markets are hoping the mess gets straightened out soon because many financial institutions own billions of dollars in stock and debt issued by Freddie Mac.

"This is not a pretty or welcome sight," says Marilyn Cohen, president of Envision Capital Management, a Los Angeles bond manager. "We thought we were at the tail end of the accounting shenanigans and corporate malfeasance."

If any of the charges turn out to be true, it will be even more surprising because Freddie Mac is considered a conservative and well-run company that does not cut corners. "I am incredulous," says Larry Platt, a mortgage banking partner at Kirkpatrick & Lockhart, a Washington law firm.

The hubbub comes at a time when the housing industry is one of the few bright spots of US economy. Low interest rates have prompted millions of Americans to either buy houses or refinance their current homes. And, Freddie Mac and Fannie Mae - which together guarantee or supply about one-third of all mortgages - have been big players in that growth. Freddie Mac, with $722 billion in assets, is now the nation's fourth largest financial institution. "They are a pillar of the housing market," says Scott Jacobson, director of research at Jefferies & Co., an investment bank.

SO FAR, the turmoil has not had any immediate impact on consumers' ability to finance mortgages.

Even before the latest headlines, the company and Fannie Mae - which helps low and moderate income home buyers - were under scrutiny by Congress. "Over the last few years there has been a debate over whether their obligations are backed by the full faith and credit of the United States," says Mr. Jacobson.

Some in Congress have also been after the company to register their mortgage securities with the Securities and Exchange Commission. Rep. Christopher Shays (R) of Connecticut and Rep. Edward Markey (D) of Massachusetts sponsored a bill in May that would require such quasi-public companies to register with the SEC and comply with the nation's securities laws. On Monday, the two representatives said this incident proved their bill was needed.

The Office of Federal Housing Enterprise Oversight (FHEO), which oversees Freddie Mac and its kin, has appointed special investigators to review Freddie Mac's accounting. According to published reports, the special audit team are citing "employee misconduct" and "management misjudgments." One issue was the refusal of the former president David Glenn to turn over a diary that includes notes from recent meetings.

"I guess the real questions are how long have they known about these problems and what took so long to do the house cleaning," says Ms. Cohen.

Jacobson says that accounting is extremely complex and includes lots of assumptions. For example, many mortgages are for 30-year terms. But, because interest rates change, individuals often prepay their mortgages and refinance with a lower rate.

To try to protect themselves from such uncertainty, many financial institutions turn to something called "derivatives." These are securities whose prices are based on another underlying investment, such as futures and options.

"I imagine that many of the assets and liabilities on the balance sheet are intangibles, such as derivatives that are very hard to value," says Mr. Platt. "Reasonable people can differ and what some might call misdeeds, others might call incorrect assumptions and that is what the review process is all about."

Closing-cost surprises sting homeowners

By Thomas A. Fogarty, USA TODAY

Not all mortgage loan settlements go as poorly as Vinny Worley's. But many do.

Check in hand, Worley went to a law office to close on a new home in Wilmington, Del. Only when the lawyer's assistant slid the settlement summary across the table did he learn he was $1,800 short.

It was the classic settlement table surprise — the too-frequent chaotic climax of the biggest, most complicated type of business deal the typical American ever undertakes. Surging home sales and serial waves of refinancings have made such surprises routine.

Last year, Americans closed on 16.9 million mortgage loans and paid an estimated $80 billion in settlement costs. Record low interest rates this year have unleashed a wave of mortgage business that is expected to swamp last year's numbers. Across the USA, tales of botched settlements have become standard chatter at cocktail parties and backyard barbecues.

Responding to widespread dissatisfaction, the Bush administration last year proposed rule changes that would simplify mortgage deals and transform the way the industry operates.

The key change would encourage lenders to offer loan applicants upfront a single guaranteed price for closing the transaction. For lenders willing to do business on that basis, the government would eliminate the thicket of regulations that now make it impractical.

Supporters say improved efficiency from the pending changes would squeeze up to $1,000 from average closing costs. The changes also would let borrowers comparison shop for the first time on the basis of just two numbers: interest rate and the fixed closing cost.

But if the proposal is to become reality, the administration will have to bull its way through opposition from tens of thousands of small mortgage-related businesses that have a financial stake in the way business gets done.

In Worley's case, the lender and the settlement attorney had overlooked a local transaction tax. Worley eventually was permitted to close the deal with a personal check on a separate account intended as a reserve for the new home.

It wasn't just the extra expense but the sheer sloppiness of the transaction that offended Worley, 33, an electrical engineer and a self-described fanatic for orderliness. "There ought to be a way to be precise about the numbers ahead of time," he says.

Settlement surprises can result from plain incompetence or honest misunderstandings. Or they can be fraud by any of the many players needed to close a deal.

John Courson, chairman of the Mortgage Bankers Association of America and a supporter of reform, told Congress this year that the complexity of the mortgage deal today is "an invitation of bait-and-switch."

Regulatory thicket

When Congress in 1974 enacted the law that governs real estate closings, a key objective was outlawing then-common kickbacks: lavish gifts and cash from lenders, title insurers, settlement agents, home inspectors and other industry players to real estate agents in return for delivering clients. The law also required extensive written disclosures so borrowers would know who was being paid what for services related to closing the mortgage.

Over time, the industry has successfully pushed government to ease the original anti-kickback provisions. Now, key players such as real estate agents and mortgage bankers can steer customers to related service providers if the link is spelled out in writing.

Critics say changes in the law over the years have produced a confusing jumble that does more to confuse borrowers than to protect them. Borrowers are not so much enlightened by the blizzard of mandatory disclosures as buried in them, critics say.

"Disclosures have so much information that they're meaningless to most customers," says Ira Rheingold, director of the National Association of Consumer Advocates.

How the law now fails to protect:

• Lenders must provide loan applicants with a "good faith" estimate of closing costs early in the process. However, they are largely free to ignore their own numbers.

• Borrowers have a legal right to see their settlement sheet — the document that itemizes all the costs — a day before closing, but few know to demand it.

• Borrowers can cancel the loan for refinancing up to three days after settlement. It is rarely done because it means starting the painful borrowing process over and possibly increasing the interest rate. In a purchase, the borrower has no comparable cancellation right.

Not just a problem for novices

The uninitiated aren't the only ones vulnerable.

As chief of realty franchiser Century 21, Van Davis is an expert in home finance. Yet when he went to settle on a purchase of a new home in Morristown, N.J., last year, costs were $3,000 more than estimated, the result mainly of a title insurance charge far in excess of what had been estimated.

Nina Simon, an attorney who represents mortgage borrowers in her job at senior-citizen advocate AARP, initially refused to settle a recent refinancing on her home in suburban Washington, D.C. The issue: An appraisal estimated at $400 was listed at settlement for $500.

Several lenders are trying to capitalize on borrower dissatisfaction. Some roll into one fee their discount points — upfront money that buys down the interest rate — and the array of profit-boosting administrative fees common in mortgage lending.

Dutch-owned ABN Amro has gone a big step beyond that. It rolls into one guaranteed fee not only the charges for its own services but those of third-party providers: appraisers, title insurers, surveyors, closing agents and the like. The only expenses to borrowers falling outside ABN Amro's guaranteed price are daily interest, mortgage taxes and pre-payments for property taxes and home insurance premiums.

Company executive Garth Graham says ABN Amro decided two years ago to guarantee one price to boost its Internet lending arm, Mortgage.com. Market research showed a recurring theme: Borrowers were frustrated and angry with ever-changing terms.

"The thing they always came back to was 'Just give me a single fee,' " Graham says.

The single-fee model

Mel Martinez, secretary of the Department of Housing and Urban Development, has been the most vocal advocate for making the single guaranteed fee the industry model.

Last summer, Martinez proposed changing federal rules to permit lenders to offer what HUD calls "guaranteed mortgage packages." In return for offering such deals, lenders would be freed from burdensome disclosure requirements at settlement time.

Under the proposal, lenders who opt not to provide an upfront guarantee of closing costs would have to close the deal within 10% of the prices that they quote in the good-faith estimate issued to the borrower at application.

The proposed rule also aims to settle one of the most contentious issues in the current process: compensation for mortgage brokers.

Squeezing out savings

Few borrowers understand that a broker commonly is paid by the lender for delivering customers who are willing to pay a higher-than-market interest rate. The Martinez proposal calls for spelling out for borrowers the terms of broker compensation.

HUD officials estimate that proposed changes could squeeze about 20% from the cost of mortgage settlements — $16 billion on the basis of 2002 business volumes. Much of the savings would come from regulatory changes that would permit lenders to seek volume discounts from service providers, such as appraisers and title companies. Under current interpretations, such discounts are thought to violate the anti-kickback provisions of the 1974 law.

HUD issued the preliminary rules for comment last summer. The agency's draft of final rules must pass review by the Office of Management and Budget. The final version could be issued this summer, officials say.

Several large mortgage lenders support Martinez's proposal for a guaranteed closing price. Anne Canfield of industry group Consumer Mortgage Coalition says the single-fee idea would quickly sweep the industry.

"Everybody's champing at the bit. This is the biggest thing going in the industry," Canfield says.

Many fingers sharing the pie

Whether final rules bear much resemblance to the original proposal remains in doubt.

Brokers, title companies, settlement attorneys, appraisers and others who draw fees from the current way of doing business say all the proposed savings from Martinez's proposal will come from their fees.

During a recent HUD comment period, opponents unleashed 40,000 complaints. And they have enlisted members of Congress.

Stanley Friedlander, president of the American Land Title Association, sounded a typical complaint at a hearing in February: "By squeezing the small (title insurance) agent, it would virtually put them out of business."

Opponents also point to ABN Amro as proof that the rule change is unnecessary. But ABN Amro's Graham, who favors industry reform, rejects that.

His company is saddled with the same costly, inefficient disclosure requirements that inhibit broader industry adoption of the single-fee approach, he says.

A promise of strong rules

Martinez says the savings from the proposed rules will come from everyone in the industry, not just the small fry. By their nature, says Martinez, real estate transactions will always be local, assuring a place for small local businesses that provide closing services.

Martinez's initiative is the latest in a series of attempts at pro-consumer reforms in the mortgage business. Inevitably, they've stalled amid intractable differences among the various players.

Rheingold, the consumer advocate, predicts HUD's pro-consumer proposals as issued last summer will be watered down when finalized. He says Martinez stumbled into stronger opposition than he bargained for.

"HUD didn't recognize all the people who get fees out of this process," he says.

Nevertheless, Martinez promises strong rules. "Failed efforts of the past were rooted in people's attempts to reach consensus," he says. "Consensus isn't possible in this case."

Charles Hora, a commercial property manager in Delray Beach, Fla., is among those hoping for an industry transformation. Hora, 58, says he can't recall an instance in his half-dozen residential mortgage transactions when a deal didn't shift substantially between application and settlement.

Says Hora: "If any other businessman acted this way, they'd call him a crook."

Regarding Freddie

Wall Street has taken a sanguine view of the big mortgage finance company's troubles.

By Justin Lahart, CNN/Money Senior Writer

NEW YORK (CNN/Money) - So far, the imbroglio at Freddie Mac has prompted a bit of hand wringing in the stock market, but little else. Let's hope it stays that way.

The mortgage-finance company's sacking of its three top executives Monday, and its stated concerns over the "cooperation and candor" of its chief operating officer, pulled the rug out from under its stock.

Freddie Mac (FRE: Research, Estimates) tumbled 16 percent in heavy trading and fellow government-sponsored mortgage-finance company Fannie Mae (FNM: Research, Estimates) sank 4.8 percent. The Dow, meanwhile, fell 82 points -- a down day, but by no means horrible.

But trouble at the mortgage finance companies could carry serious implications for the overall economy. If credit market players begin to seriously question either Freddie or Fannie's business, their borrowing costs could shoot up. That would send mortgage rates -- currently at all-time lows -- higher.

That would ripple badly through a financial sector which has become increasingly dependent on investments in the tradable bundles of mortgages called mortgage-backed securities to make profits.

"Imagine you're a bank," said Lehman Brothers chief economist Ethan Harris. "The corporate sector isn't interested in borrowing, so you can't lend to it. So where do you go? Well, mortgages. They pay a reasonable rate. They're seen as a safe investment. Load up on mortgage-backed securities."

Indeed, banks have been loading up on mortgage-backeds at a prodigious rate -- at the end of May they held 43 percent more than they did a year ago, according to the Federal Reserve.

Other investors, too, have been "surfing" the yield curve by taking advantage of low short-term borrowing costs to buy mortgages. The Fed, after all, in its all-out bid to revive the economy, has more or less promised to keep short-term rates low, so buying up mortgages doesn't seem so dangerous.

And those low mortgage rates are doing wonders for the economy. The Mortgage Bankers Association estimates that there will by over $3 trillion in mortgages originated this year, up from about $2.5 trillion last year. Mortgage refinance activity is going strong, putting money into consumers' pockets and keeping spending going. Problems in mortgage-land could put an end to all that.

Which, of course, is not something that anyone wants to see happen. Various officials, like Fed Chairman Alan Greenspan, sometimes complain that when it comes to Freddie and Fannie, investors have become too complacent, believing that the two mortgage companies are "too big to fail," and that in the event of serious trouble, the government will bail them out.

Given the present circumstances, can you imagine that the government wouldn't?

Homeowners on a refinancing kick should take heed of possible pitfalls, experts advise

By Jennifer Davies
UNION-TRIBUNE STAFF WRITER

The home refinancing mania that has gripped the country has been good for homeowners and the feeble economy.

Homeowners have been able to cut their monthly payments and reap huge cash windfalls by refinancing as interest rates plummeted and housing prices skyrocketed. That "extracted equity," as Fed Chairman Alan Greenspan likes to call the refinancing boom, has spurred additional consumer spending at a time when companies are cutting jobs and other expenses.

In 2002, homeowners converted more than $96 billion of their home equity into cash, propping up the economy through home improvements, car purchases and repayment of consumer debt, said Amy Crew Cutts, deputy chief economist of Freddie Mac, the home loan mortgage company. The refinancing boom has continued into this year, with some $24 billion in equity converted to cash thus far.

"But that has hardly made a dent in the $6 trillion worth of equity value held in single-family homes," Cutts said. "By reducing their mortgage costs through refinancing, homeowners are saving a little more than $110 a month on average, and in aggregate that adds up to some $300 million per month in extra spending money for those homeowners to put back into the economy."

The refinancing bonanza that has kept consumer confidence from cratering could turn into a bust if the housing market cools or the economy further swoons. That could usher in an ugly chapter of high bankruptcy and foreclosure rates.

The nightmare scenario goes something like this: Interest rates rise and housing prices fall. The economy fails to recover and unemployment climbs. Those who have refinanced their homes, taking out cash to pay off credit card debts or purchase new cars, could end up owing more on their houses than they are worth.

Overleveraged homeowners who lose their jobs due to cutbacks would be unable to sell their houses for as much as they owe on them. Unable to make the monthly payments, the overextended consumers could face bankruptcy and even foreclosure.

"My opinion is that everyone is refinancing to death," said Ken Pecus, a real estate agent with California Prudential in San Diego. "People are mortgaging their futures by not paying attention."

Pecus' opinions are shared by many in the mortgage industry and bankruptcy attorneys who see the potential pitfalls of the refinancing boom.

While San Diego's housing market continues to soar, some parts of the country are seeing a stagnation in housing prices and a corresponding increase in foreclosures that could be a sign of things to come.

Indiana is a prime example. According to the National Association of Realtors, Indiana's home foreclosure rate last year was 2.38 percent, more than double the national average. Not coincidentally, the state also has one of the most tepid housing appreciation rates in the country. The Indiana Mortgage Bankers Association reported that Indianapolis' home appreciation rate was 3.71 percent, about half the national average. Indiana has been hit especially hard by unemployment, losing 4.1 percent of its jobs from 2000 to 2002 while the rest of the country lost .9 percent of its jobs.

Already bankruptcies are skyrocketing in some parts of the country, including the East Coast, said Keith Herron, a bankruptcy attorney in San Diego. The number of U.S. bankruptcy filings reached a record in the first quarter of 2003, according the Administrative Office of the U.S. Courts. In the first three months of this year, there were 412,968 bankruptcy filings. The previous record for filings was in Sept. 30, 2002, when there were 401,306 filings.

It's only a matter of time before the bankruptcy phenomenon makes its way to California, Herron said.

"When the bubble breaks – and I'm still waiting for it to happen – there are going to be some very serious repercussions," Herron said.

Not everyone sees the mass refinancing boom in a dark light. At a recent congressional hearing, Greenspan lauded the unprecedented ability Americans have had to turn their home equity into cold hard cash.

"Surveys by the Federal Reserve indicate that equity extraction from homes ... tend to be very significantly employed to repay other debt," Greenspan said, adding that refinancings "have also shown up as a major factor in reducing the burden of consumer debt."

Still, some bankruptcy attorneys and mortgage brokers see clients who look at refinancing cash or home equity lines of credit as free money and are cruising for trouble.

John Yeager of Yeager & Associates/American Mortgage Express said with the huge run-

up in housing prices, people are able to pay off their debts and get tax deductions on the refinancing.

"The problem is that temptation and human nature kicks in, and they run up more debt," Yeager said. "Six months to a year later, they are in the same position."

While Yeager said his clients are fairly responsible, he estimates that 10 percent to 20 percent of homeowners are getting themselves into trouble by misusing the equity in their home.

Ted Grose, president of the California Association of Mortgage Brokers, said the relative ease with which a homeowner can refinance could result in what he calls pyramiding debt.

With all the money flowing from refinancing, there still has not been a significant decrease in consumer debt, he said. A recent report by UBS Warburg found that consumer debt grew by 10 percent in 2001 and 2002.

"You would expect some of that freed-up money would go to pay down debt," Grose said. "The unfortunate consequence is that consumer debt continues to climb."

Mike Philips, San Diego area manager for Wells Fargo's Home Mortgage department, said about two-thirds of the bank's mortgage business is refinancing. Homeowners are refinancing for a variety of reasons: to lower rates, shorten the term of their mortgages or, as Philips put it, "leverage their lifestyles."

The scary part of using home equity to pay off credit cards or make big-ticket purchases is that it converts unsecured debt, which can be erased in a bankruptcy filing, into secured debt in the house, which cannot be written off. If homeowners fall behind in their payments or run into money troubles, that means they can lose their house, said Kerry Denton, a San Diego bankruptcy attorney.

While bankruptcies are down in California, Denton said he expects that could change.

"If something does give and the economy goes bad, you will see the bankruptcy filings go up and more of those people will lose their homes," he said.

The nightmare scenario depends on a significant depreciation in home values. While many believe that the skyrocketing cost of houses in California, and San Diego, will eventually slow down, few see the local market collapsing.

San Diego's economy is not only stronger than most parts of the country, but the region still lacks an adequate supply of housing, said Alan Gin, a professor at University of San Diego's Real Estate Institute. During the 1990s not enough homes were built for the growing population, and it will be a long time before supply and demand come into line. Because of the lack of supply, San Diego's housing market won't be hurt as badly as other regions when mortgage rates do go up.

In fact, Gin is refinancing his own home to bring down his monthly costs.

"The high payment is stressful," he said. "I'm going to reduce it by about $900."

For those who look to reduce payments or shorten the term of their mortgage, refinancing can be positive, said Wells Fargo's Philips.

But the downside of refinancing also can be more subtle, said Pecus, the real estate agent. People who chase after the lowest rates reset the clock on their mortgages, further extending the time it will take to pay off their loans. A mortgage isn't a big deal for someone in their 30s, but when a homeowner reaches retirement age, a big mortgage can be daunting.

"This generation will never pay off their homes," Pecus said.

Philips said there are customers who have refinanced their homes two, three and even four times as rates have fallen to lows not seen since the 1950s. The run-up in housing prices and the low interest rates have caused many in San Diego to view their homes as an investment, Philips said.

That type of thinking could cause problems if the housing market stalls or falls.

"A lot of people are considering their home only as an investment," Philips said. "But you have to look at your home and say, 'I have to live there and be able to afford to live there.' If you do that, you won't get into trouble."

To rebuild, housing agency has to uproot

By Stuart Eskenazi

Seattle Times staff reporter

Katie Ngo was in denial about having to move from the comforts of her home.

Rainier Vista, the low-income housing project where the young single mother lived, was being demolished as part of a $750 million makeover of public housing in Seattle. Her landlord, the Seattle Housing Authority (SHA), offered Ngo two options for relocating, but she rejected both because they required her to move from Rainier Valley. Her job, her child's day care, her mother, her friends were all there.

"Who would want to change all of that, right?" she said.

But change has been necessary for about 1,600 low-income households in Seattle that have had to move since 1996 to accommodate the redevelopment of Holly Park (now NewHolly), Rainier Vista and High Point.

Each is being transformed from a sprawl of public housing into a new neighborhood where poor people live side by side with market-rate renters and homeowners.

Ngo's decision on where to move became easier after she switched jobs. Although her stubbornness had made life difficult on her relocation counselors at Rainier Vista, the Housing Authority recruited her to counsel residents at High Point in West Seattle.

She brought to the job an intimate appreciation for the disruption that an imposed move can have on a family. When her duties ended last month, she left convinced that SHA is making the best of a tough situation.

A recent city audit of SHA's completed relocation effort at Holly Park, where 832 households had to move, concluded the same thing. Auditors gave SHA good marks for keeping residents informed and helping them find satisfactory new homes.

But those who urged the City Council to order the audit dismiss it as cursory and misleading.

John Fox, head of the Seattle Displacement Coalition, said the audit failed to address whether displaced residents received all relocation benefits they were entitled to under federal law.

He also said the coalition has evidence SHA broke promises, including a guarantee that residents could return to NewHolly after construction and that their new rent would not exceed 30 percent of their income for four years after their move.

The audit is based on SHA case files of 59 uprooted households. The auditor queried only four families, however — a laughably small sample from which to draw conclusions, Fox said.

Councilman Nick Licata, who requested the audit, did not respond to several phone messages for this story.

Each relocation experience is a unique story, with residents choosing from several options.

Many leaped at the opportunity to take a Section 8 voucher, which allows low-income people to rent in the open market with the government picking up a share of the expenses.

Others chose to stay in the same housing project, moving to areas not under construction, which has been possible because the work is occurring in phases.

A few accepted lump sums of about $1,500. Some seniors accepted a similar payment and moved into private facilities or in with family.

Ngo, like several residents, moved to West Seattle, to one of the many SHA-run properties scattered throughout the city.

Ngo said a lot of her job at High Point was trying to allay anxieties, understanding that people in public housing already have plenty of stresses in their lives. "Some residents had lived there 10 years or more," she said. "The older folks, especially, didn't like having to move."

They bemoaned the loss of longtime neighbors and worried about moving farther from doctors and bus lines. Some expressed fears of becoming homeless.

For SHA, relocation has been like solving a puzzle, matching available public housing with residents while trying to grant their first preferences. According to the audit:

• At Holly Park, 70 percent of 832 relocated households received their first preferences for new housing. The number rises to 85 percent when circumstances not the fault of SHA are taken into account, such as a family being unable to buy a house as hoped.

• At Rainier Vista, where demolition west of Martin Luther King Jr. Way South is almost done, the first phase of relocation ended last spring, said Virginia Felton, SHA's communications director. Of the 471 households at Rainier Vista at the time it began, 376 have moved. Of those, 100 took Section 8 vouchers, 99 moved to the eastern section not under construction, 57 moved to other SHA housing across the city, and four bought homes. The circumstances of the remaining residents who left varied.

• At High Point, where the first phase of relocation finished in April but construction does not begin until this summer, 516 of the 702 eligible households have moved, Felton said. Of those, 421 moved off-site, and 95 moved to the section of High Point not slated for demolition right away.

"Not to downplay the disruption the redevelopments have caused, but in any public-housing environment about half of the residents move during a five-year period anyway," Felton said.

As the SHA refines its relocation process, the King County Housing Authority is taking note. At its Park Lake Homes in White Center, 569 units for low-income tenants will be demolished starting in 2005, to be replaced by a mixed-income neighborhood of 900 to 1,100 new homes.

Relocation trends have changed since the process began in 1996, said Willard Brown, SHA's redevelopment property manager. At Holly Park, few residents expressed interest in moving back into the development after it became NewHolly, while at Rainier Vista and High Point, many residents wanted in when the redevelopments are completed.

"What we didn't fully understand at Holly Park was the general stigma and negativity attached to living there," he said.

Residents doubted NewHolly would offer them a better life, Brown said. But now that SHA can point to the completed phases of NewHolly as a model, Rainier Vista and High Point residents are more interested in SHA's redeveloped neighborhoods.